##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


---



FORM 10-Q


(Mark One)

|    |  |                                                                   
|--- |  | ------------------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
|    |  | EXCHANGE ACT OF 1934                                              

For the quarterly period ended June 30, 2002

or

|      |  |                                                                    
|----- |  | -------------------------------------------------------------------
|[   ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
|      |  | EXCHANGE ACT OF 1934                                               

Commission File Number 000-24289

CLICK2LEARN, INC.

(Exact name of registrant as specified in its charter)


|                                                                                   |  |                                                
|---------------------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware
(State or other jurisdiction of incorporation or organization)            |  | 91-1276003
(I.R.S. Employer Identification No.)
|                                                                                  
|110-110th Avenue NE, Bellevue, Washington
(Address of principal executive offices) |  | 98004
(Zip Code)                               

(425) 462-0501
(Registrants telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes  [X]     No  [   ]

The number of shares outstanding of the issuers Common Stock, par value $0.01,
as of June 30, 2002 was 24,290,753 shares.



---

---





---

TABLE OF CONTENTS



|                          |                                                                                               |                                                      |  |  |  |  |  | 
|------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|                          |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                          |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                          |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                          |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                          | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                          | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|PART IIOTHER INFORMATION
|                          | Item 1. Legal Proceedings                                                                    
|                          | Item 2. Changes In Securities and Use of Proceeds                                            
|                          | Item 3. Defaults Upon Senior Securities                                                      
|                          | Item 4. Submission of Matters to a Vote of Securities Holders                                
|                          | Item 5. Other Information.                                                                   
|                          | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES               
|EXHIBIT LIST             
|EXHIBIT 10.01            
|EXHIBIT 99.1             
|EXHIBIT 99.2             



---



##### Table of Contents



CLICK2LEARN, INC.

FORM 10-Q

For the Quarter Ended June 30, 2002

TABLE OF CONTENTS

|                               |  |                                                                                                           |  |      |  | 
|------------------------------ |  | --------------------------------------------------------------------------------------------------------- |  | ---- |  | 
|                               |  |                                                                                                           |  | Page
|                               |  |                                                                                                           |  |     
|PART I  FINANCIAL INFORMATION |  |                                                                                                           |  |     
|                              
|Item 1.                        |  | Financial Statements                                                                                      |  |      |  | 
|                              
|                               |  | Condensed Consolidated Balance Sheets as of June 30, 2002 and December 31, 2001                           |  |      |  | 
|                              
|                               |  | Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2002 and 2001 |  |      |  | 
|                              
|                               |  | Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001           |  |      |  | 
|                              
|                               |  | Notes to Condensed Consolidated Financial Statements                                                      |  |      |  | 
|                              
|Item 2.                        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  |      |  | 
|                              
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                                                |  |      |  | 
|                              
|PART II  OTHER INFORMATION    |  |                                                                                                           |  |     
|                              
|Item 1.                        |  | Legal Proceedings                                                                                         |  |      |  | 
|                              
|Item 2.                        |  | Change in Securities and Use of Proceeds                                                                  |  |      |  | 
|                              
|Item 3.                        |  | Defaults upon Senior Securities                                                                           |  |      |  | 
|                              
|Item 4.                        |  | Submission of Matters to a Vote of Securities Holders                                                     |  |      |  | 
|                              
|Item 5.                        |  | Other Information                                                                                         |  |      |  | 
|                              
|Item 6.                        |  | Exhibits and Reports on Form 8-K                                                                          |  |      |  | 
|                              
|SIGNATURES                     |  |                                                                                                           |  |     

2



---



##### Table of Contents






CLICK2LEARN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)

|                                          |                                                                                                              |  |       |                                            |   |          |        |              |   |   |        | 
|----------------------------------------- | ------------------------------------------------------------------------------------------------------------ |  | ----- | ------------------------------------------ | - | -------- | ------ | ------------ | - | - | ------ | 
|                                          |                                                                                                              |  |       |                                            |   | June 30, |        | December 31,
|                                          |                                                                                                              |  |       |                                            |   | 2002     |        | 2001        
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|Assets                                    |                                                                                                              |  |       |                                            |   |          |        |             
|Current assets:                           |                                                                                                              |  |       |                                            |   |          |        |             
|                                          | Cash and cash equivalents                                                                                    |  | $     | 4,979                                      |   |          | $      | 9,553        |  
|                                          | Accounts receivable, net of allowance for returns and doubtful accounts of $1,138 in 2002 and $1,430 in 2001 |  |       | 13,853                                     |   |          |        | 19,449       |  
|                                          | Inventories                                                                                                  |  |       | 64                                         |   |          |        | 62           |  
|                                          | Prepaid royalties and licenses                                                                               |  |       | 239                                        |   |          |        | 180          |  
|                                          | Receivables from related companies                                                                           |  |       | 25                                         |   |          |        | 9            |  
|                                          | Other                                                                                                        |  |       | 930                                        |   |          |        | 1,001        |  
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total current assets                       |   |          | 20,090 |              |   |   | 30,254 | 
|Property and equipment, net               |                                                                                                              |  | 1,590 |                                            |   |          | 2,250  |             
|Goodwill and other intangible assets, net |                                                                                                              |  | 8,083 |                                            |   |          | 6,061  |             
|Other                                     |                                                                                                              |  | 623   |                                            |   |          | 789    |             
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total assets                               |   | $        | 30,386 |              |   | $ | 39,354 | 
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|Liabilities and Stockholders Equity      |                                                                                                              |  |       |                                            |   |          |        |             
|Current liabilities:                      |                                                                                                              |  |       |                                            |   |          |        |             
|                                          | Accounts payable                                                                                             |  | $     | 3,426                                      |   |          | $      | 2,617        |  
|                                          | Accrued compensation and benefits                                                                            |  |       | 2,885                                      |   |          |        | 2,788        |  
|                                          | Deferred revenue                                                                                             |  |       | 2,181                                      |   |          |        | 2,453        |  
|                                          | Customer prepayments                                                                                         |  |       | 83                                         |   |          |        | 166          |  
|                                          | Other                                                                                                        |  |       | 1,554                                      |   |          |        | 1,353        |  
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total current liabilities                  |   |          | 10,129 |              |   |   | 9,377  | 
|Other noncurrent liabilities              |                                                                                                              |  | 167   |                                            |   |          | 417    |             
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total liabilities                          |   |          | 10,296 |              |   |   | 9,794  | 
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|Stockholders equity:                     |                                                                                                              |  |       |                                            |   |          |        |             
|                                          | Preferred stock                                                                                              |  |       |                                           |   |          |        |             |  
|                                          | Common stock                                                                                                 |  |       | 244                                        |   |          |        | 242          |  
|                                          | Additional paid-in capital                                                                                   |  |       | 242,197                                    |   |          |        | 241,769      |  
|                                          | Accumulated deficit                                                                                          |  |       | (221,800                                   | ) |          |        | (211,894     | )
|                                          | Deferred stock compensation                                                                                  |  |       |                                           |   |          |        | (5           | )
|                                          | Accumulated other comprehensive loss                                                                         |  |       | (551                                       | ) |          |        | (552         | )
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total stockholders equity                 |   |          | 20,090 |              |   |   | 29,560 | 
|                                          |                                                                                                              |  |       |                                            |   |          |        |             
|                                          |                                                                                                              |  |       | Total liabilities and stockholders equity |   | $        | 30,386 |              |   | $ | 39,354 | 
|                                          |                                                                                                              |  |       |                                            |   |          |        |             

See accompanying notes to Condensed Consolidated Financial Statements

3



---



##### Table of Contents






CLICK2LEARN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)

|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |        |        | 
|------------------------------------------------------------- | -------------------------------------------- | ------------------------ | ------ | ------------------ | ----- | ---------------- | ------ | ----- | ------ | ---- | ------- | ------ | ------ | - | ------ | ------ | ------ | 
|                                                              |                                              |                          |        | Three months ended |       | Six months ended
|                                                              |                                              |                          |        | June 30,           |       | June 30,        
|                                                              |                                              |                          |        |                    |       |                 
|                                                              |                                              |                          |        | 2002               |       | 2001             |        | 2002  |        | 2001
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |     
|Revenue:                                                      |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              | Platforms                                    |                          | $      | 5,518              |       |                  | $      | 4,624 |        |      | $       | 10,936 |        |   | $      | 7,629  |       
|                                                              | Content services                             |                          |        | 875                |       |                  |        | 5,267 |        |      |         | 1,729  |        |   |        | 10,895 |       
|                                                              | Tools                                        |                          |        | 1,236              |       |                  |        | 1,805 |        |      |         | 2,495  |        |   |        | 3,826  |       
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              |                                              | Total revenue            |        |                    | 7,629 |                  |        |       | 11,696 |      |         |        | 15,160 |   |        |        | 22,350 | 
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Cost of revenue:                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              | Platforms                                    |                          |        | 1,480              |       |                  |        | 784   |        |      |         | 3,054  |        |   |        | 1,439  |       
|                                                              | Content services                             |                          |        | 1,334              |       |                  |        | 4,657 |        |      |         | 3,549  |        |   |        | 9,787  |       
|                                                              | Tools                                        |                          |        | 287                |       |                  |        | 450   |        |      |         | 682    |        |   |        | 936    |       
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              |                                              | Total cost of revenue    |        |                    | 3,101 |                  |        |       | 5,891  |      |         |        | 7,285  |   |        |        | 12,162 | 
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Gross margin                                                  |                                              |                          | 4,528  |                    |       |                  | 5,805  |       |        |      | 7,875   |        |        |   | 10,188 |       
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Operating expenses:                                           |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              | Research and development                     |                          |        | 2,404              |       |                  |        | 2,142 |        |      |         | 4,685  |        |   |        | 4,483  |       
|                                                              | Sales and marketing                          |                          |        | 4,831              |       |                  |        | 5,003 |        |      |         | 9,263  |        |   |        | 9,658  |       
|                                                              | General and administrative                   |                          |        | 1,436              |       |                  |        | 1,597 |        |      |         | 3,485  |        |   |        | 3,234  |       
|                                                              | Amortization of goodwill                     |                          |        |                   |       |                  |        | 312   |        |      |         |       |        |   |        | 551    |       
|                                                              | Employee severance and excess facility costs |                          |        |                   |       |                  |        |      |        |      |         | 1,138  |        |   |        |       |       
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|                                                              |                                              | Total operating expenses |        |                    | 8,671 |                  |        |       | 9,054  |      |         |        | 18,571 |   |        |        | 17,926 | 
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Loss from operations                                          |                                              |                          | (4,143 | )                  |       |                  | (3,249 | )     |        |      | (10,696 | )      |        |   | (7,738 | )     
|Gain on sale of assets                                        |                                              |                          |       |                    |       |                  |       |       |        |      | 927     |        |        |   |       |       
|Other income (expense), net                                   |                                              |                          | (3     | )                  |       |                  | 83     |       |        |      | 13      |        |        |   | 255    |       
|Equity in losses of affiliate                                 |                                              |                          | (75    | )                  |       |                  | (100   | )     |        |      | (150    | )      |        |   | (200   | )     
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Net loss                                                      |                                              | $                        | (4,221 | )                  |       | $                | (3,266 | )     |        | $    | (9,906  | )      |        | $ | (7,683 | )     
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Net loss per share, basic and diluted                         |                                              | $                        | (.17   | )                  |       | $                | (.17   | )     |        | $    | (.41    | )      |        | $ | (.42   | )     
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       
|Weighted average common shares outstanding, basic and diluted |                                              |                          | 24,271 |                    |       |                  | 18,762 |       |        |      | 24,235  |        |        |   | 18,403 |       
|                                                              |                                              |                          |        |                    |       |                  |        |       |        |      |         |        |        |   |        |       

See accompanying notes to Condensed Consolidated Financial Statements

4



---



##### Table of Contents






CLICK2LEARN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |        |       |        |         |  
|------------------------------------- | --------------------------------------------------------------------------- | -------------------------------------------------------------- | ---------------------------------- | ----------------------------------------- | ------ | ------------------------- | ------ | ------ | ----- | ------ | ------- | -
|                                      |                                                                             |                                                                |                                    |                                           |        | Six Months Ended June 30,
|                                      |                                                                             |                                                                |                                    |                                           |        |                          
|                                      |                                                                             |                                                                |                                    |                                           |        | 2002                      |        | 2001  
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|Cash flows from operating activities: |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      | Net loss                                                                    |                                                                | $                                  | (9,906                                    | )      |                           | $      | (7,683 | )    
|                                      | Adjustments to reconcile net loss to net cash used in operating activities: |                                                                |                                    |                                           |        |                           |        |        |      
|                                      |                                                                             | Depreciation and amortization                                  |                                    |                                           | 1,196  |                           |        |        | 1,539 |       
|                                      |                                                                             | Write-off property and equipment                               |                                    |                                           | 270    |                           |        |        |      |       
|                                      |                                                                             | Stock compensation expense                                     |                                    |                                           | 5      |                           |        |        | 96    |       
|                                      |                                                                             | Gain on sale of assets                                         |                                    |                                           | (908   | )                         |        |        |       |       
|                                      |                                                                             | Equity in losses of affiliate                                  |                                    |                                           | 150    |                           |        |        | 200   |       
|                                      |                                                                             | Changes in assets and liabilities:                             |                                    |                                           |        |                           |        |        |       |       
|                                      |                                                                             |                                                                | Accounts receivable                |                                           |        | 5,594                     |        |        |       | (2,899 | )      
|                                      |                                                                             |                                                                | Inventories                        |                                           |        | (2                        | )      |        |       | 60     |        
|                                      |                                                                             |                                                                | Prepaid royalties and licenses     |                                           |        | (59                       | )      |        |       | 105    |        
|                                      |                                                                             |                                                                | Receivables from related companies |                                           |        | (16                       | )      |        |       |       |        
|                                      |                                                                             |                                                                | Other current assets               |                                           |        | 35                        |        |        |       | (566   | )      
|                                      |                                                                             |                                                                | Accounts payable                   |                                           |        | 808                       |        |        |       | (605   | )      
|                                      |                                                                             |                                                                | Accrued liabilities                |                                           |        | 96                        |        |        |       | (552   | )      
|                                      |                                                                             |                                                                | Deferred revenue                   |                                           |        | (272                      | )      |        |       | 766    |        
|                                      |                                                                             |                                                                | Other current liabilities          |                                           |        | (269                      | )      |        |       | (208   | )      
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      |                                                                             |                                                                |                                    | Net cash used in operating activities     |        |                           | (3,278 | )      |       |        | (9,747  | )
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      | Cash flows from investing activities:                                       |                                                                |                                    |                                           |        |                           |        |        |      
|                                      |                                                                             | Purchase
of property and equipment and other intangible assets |                                    |                                           | (2,880 | )                         |        |        | (581  | )     
|                                      |                                                                             | Proceeds from sale of assets                                   |                                    |                                           | 1,000  |                           |        |        |      |       
|                                      |                                                                             | Payments related to acquisitions, net of cash acquired         |                                    |                                           |       |                           |        |        | 112   |       
|                                      |                                                                             | Investment in Click2learn Japan KK                             |                                    |                                           |       |                           |        |        | (639  | )     
|                                      |                                                                             | Sale (purchase) of other assets                                |                                    |                                           | 16     |                           |        |        | (4    | )     
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      |                                                                             |                                                                |                                    | Net cash used in investing activities     |        |                           | (1,864 | )      |       |        | (1,112  | )
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      | Cash flows from financing activities:                                       |                                                                |                                    |                                           |        |                           |        |        |      
|                                      |                                                                             | Borrowings under (repayment) of debt                           |                                    |                                           | 137    |                           |        |        | (4    | )     
|                                      |                                                                             | Proceeds from exercise of stock options                        |                                    |                                           | 95     |                           |        |        | 46    |       
|                                      |                                                                             | Proceeds from sale of common stock                             |                                    |                                           | 335    |                           |        |        | 571   |       
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      |                                                                             |                                                                |                                    | Net cash provided by financing activities |        |                           | 567    |        |       |        | 613     |  
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      |                                                                             | Effect of foreign exchange rate changes                        |                                    |                                           | 1      |                           |        |        | (59   | )     
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      |                                                                             |                                                                |                                    | Net decrease in cash and cash equivalents |        |                           | (4,574 | )      |       |        | (10,305 | )
|                                      | Cash and cash equivalents at beginning of period                            |                                                                |                                    | 9,553                                     |        |                           |        | 15,321 |      
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       
|                                      | Cash and cash equivalents at end of period                                  |                                                                | $                                  | 4,979                                     |        |                           | $      | 5,016  |      
|                                      |                                                                             |                                                                |                                    |                                           |        |                           |        |       

See accompanying notes to Condensed Consolidated Financial Statements

5



---



##### Table of Contents






CLICK2LEARN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002 AND 2001

Unaudited Interim Financial Information

The accompanying unaudited condensed consolidated financial statements of
Click2learn, Inc. (Click2learn) include the accounts of Click2learn and its
wholly owned subsidiaries. All significant intercompany transactions have been
eliminated in consolidation.

These statements reflect all normal recurring adjustments which are, in
the opinion of management, necessary for a fair presentation of the financial
position and results of operations for the periods presented. Interim results
of operations for the three and six months ended June 30, 2002 are not
necessarily indicative of the operating results for the full fiscal year.
Factors that may affect such operating results, include, but are not limited
to, those discussed in Factors That May Affect Future Results of Operations".
Certain information and footnote disclosures normally included in financial
statements prepared in conformity with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. These condensed consolidated financial statements should be read in
conjunction with the consolidated financial statements and related
notes included in Click2learns Annual Report on Form 10-K for the
year ended December 31, 2001.

Net Loss Per Share

Basic net loss per share is computed by dividing the net loss by the
weighted average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing the net loss by the weighted
average number of common and dilutive shares outstanding during the period. As
Click2learn had a net loss in each of the periods presented, basic and diluted
net loss per share are the same.

Excluded from the computation of diluted earnings per share for the three
and six months ended June 30, 2002 are options to acquire approximately
5,396,505 shares of common stock with a weighted average exercise price of
$6.02 and warrants to purchase 3,633,686 shares of common stock with a weighted
average exercise price of $5.75 because their effects would be anti-dilutive.
Options to acquire approximately 5,469,500 shares of common stock with a
weighted average exercise price of $7.53 and warrants to purchase 1,797,829
shares of common stock with a weighted exercise share price of $8.45 have been
excluded from the computation of diluted earnings per share for the three and
six months ended June 30, 2001 because their effects would be anti-dilutive.

Revenue Recognition

Click2learn recognizes revenue in accordance with Statement of Position
97-2 (SOP 97-2), Software Revenue Recognition, issued by the American
Institute of Certified Public Accountants, which, as modified, stipulates that
revenue recognized from software arrangements is to be allocated to each
element of the arrangement based upon the relative fair values of the elements,
such as software products, upgrades, enhancements, post-contract customer
support, installation or training, using evidence which is specific to Click2learn. If such evidence of fair value for each element does not exist,
all revenue from the arrangement is deferred until such time that fair value
does exist or until all elements are delivered. Revenue from software licenses
is recognized upon shipment provided no significant obligations remain
outstanding and collection of the resulting receivable is probable. An
allowance for returns is provided at the time of the sale. Revenue from
support agreements is recognized over the life of the contract.

Professional services revenue is recognized from fixed price contracts as
services are provided or by using the percentage-of-completion method of
accounting, based on the ratio of costs incurred to the total estimated project
cost, for individual fixed-price contracts. Provisions for any estimated
losses on uncompleted contracts are made in the period in which such losses
become evident.

Revenue from the e-Learning Network includes site fees, hosting,
royalties, and content sales. The revenues are determined by individual
contracts, one to three years in length, which specify functionality of the
site and the commerce conducted on the site. The e-Learning Network fees are
recognized ratably over the life of the contract. Royalty revenue is
recognized as earned. Content revenue is either recognized evenly over the life
of the contract for

6



---



##### Table of Contents



course usage on bundled curriculum courses or recognized at the time of the
purchase of individual e-Learning courses. Revenues from tangible goods,
including books, videotapes and CD-ROMs are recognized at the time of shipment.

Comprehensive Loss and Accumulated Other Comprehensive Loss

The following table sets forth the components of comprehensive loss for
the periods presented below:

|                                        |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|--------------------------------------- |  | ------------------ | ------ | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                        |  | Three Months Ended |        | Six Months Ended
|                                        |  | June 30,           |        | June 30,        
|                                        |  |                    |        |                 
|                                        |  | 2002               |        | 2001             |  | 2002 |        | 2001
|                                        |  |                    |        |                  |  |      |        |     
|Net loss                                |  | $                  | (4,221 | )                |  | $    | (3,266 | )    |  | $ | (9,906 | ) |  | $ | (7,683 | )
|Foreign currency translation adjustment |  |                    | 12     |                  |  |      | 83     |      |  |   | 1      |   |  |   | (57    | )
|                                        |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  
|Total comprehensive loss                |  | $                  | (4,209 | )                |  | $    | (3,183 | )    |  | $ | (9,905 | ) |  | $ | (7,740 | )
|                                        |  |                    |        |                  |  |      |        |      |  |   |        |   |  |   |        |  

Accumulated other comprehensive loss at June 30, 2002 and December 31,
2001 consists of foreign currency translation adjustments.

Derivative Financial Instruments

Click2learn had no derivative financial instruments outstanding at June
30, 2002.

Adoption of Accounting Pronouncements

In July 2001, the
Financial Accounting Standards Board issued Statement
No. 141 Business Combinations and Statement No. 142 Goodwill and Other
Intangible Assets. Statement No. 141 requires business combinations initiated
after June 30, 2001 to be accounted for using the purchase method of
accounting, and specifies criteria for recognizing intangible assets acquired
in a business combination. Statement No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually. Intangible assets with
definite useful lives will continue to be amortized over their respective
estimated useful lives.

Click2learn adopted the provisions of Statement No. 141 as of July 1,
2001. No business combinations have been initiated since July 1, 2001.
Goodwill resulting from business combinations completed prior to June 30, 2001
was amortized through December 31, 2001. Based upon Click2learns analysis,
there was no impairment of goodwill upon adoption of Statement 142 on January
1, 2002 upon completion of the transitional goodwill impairment test.
Click2learns identifiable intangible assets as of January 1, 2002 consisted of
acquired technology. Click2learn has reviewed the useful lives of identifiable
intangible assets as of January 1, 2002 and determined that the original useful
lives of 3 to 5 years was appropriate. Click2learn plans to conduct its annual
goodwill impairment testing during the fourth quarter of the year.

7



---



##### Table of Contents



Net loss and loss per share for the three and six months ended June 30,
2001 adjusted to exclude goodwill amortization expense are as follows (in
thousands, except per share data):

|                                      |                       |                         |                                               |                   |      |              |        |            |      |      |        |  
|------------------------------------- | --------------------- | ----------------------- | --------------------------------------------- | ----------------- | ---- | ------------ | ------ | ---------- | ---- | ---- | ------ | -
|                                      |                       |                         |                                               |                   |      | Three
Months |        | Six Months
|                                      |                       |                         |                                               |                   |      | Ended        |        | Ended     
|                                      |                       |                         |                                               |                   |      | June 30,     |        | June 30,  
|                                      |                       |                         |                                               |                   |      |              |        |           
|                                      |                       |                         |                                               |                   |      | 2001         |        | 2001      
|                                      |                       |                         |                                               |                   |      |              |        |           
|Net loss:                             |                       |                         |                                               |                   |      |              |        |           
|                                      | Reported net loss     |                         | $                                             | (3,266            | )    |              | $      | (7,683     | )   
|                                      | Goodwill amortization |                         |                                               | 312               |      |              |        | 551        |     
|                                      |                       |                         |                                               |                   |      |              |        |           
|                                      |                       |                         |                                               | Adjusted net loss |      | $            | (2,954 | )          |      | $    | (7,132 | )
|                                      |                       |                         |                                               |                   |      |              |        |           
|Basic and diluted net loss per share: |                       |                         |                                               |                   |      |              |        |           
|                                      |                       | Reported loss per share |                                               |                   | (.17 | )            |        |            | (.42 | )   
|                                      |                       | Goodwill amortization   |                                               |                   | .01  |              |        |            | .03  |     
|                                      |                       |                         |                                               |                   |      |              |        |           
|                                      |                       |                         | Adjusted basic and diluted
net loss per share |                   | $    | (.16         | )      |            | $    | (.39 | )     
|                                      |                       |                         |                                               |                   |      |              |        |           

Net loss and loss per share for the years ended 2001, 2000, and 1999
adjusted to excluded goodwill amortization expense are as follow (in thousands,
expect per share data):

|                                      |                       |                         |                                               |                   |      |      |         |         |      |      |         |         |      |      |        |  
|------------------------------------- | --------------------- | ----------------------- | --------------------------------------------- | ----------------- | ---- | ---- | ------- | ------- | ---- | ---- | ------- | ------- | ---- | ---- | ------ | -
|                                      |                       |                         |                                               |                   |      | 2001 |         | 2000    |      | 1999
|                                      |                       |                         |                                               |                   |      |      |         |         |      |     
|Net loss:                             |                       |                         |                                               |                   |      |      |         |         |      |      |         |        
|                                      | Reported net loss     |                         | $                                             | (19,581           | )    |      | $       | (16,786 | )    |      | $       | (10,005 | )   
|                                      | Goodwill amortization |                         |                                               | 1,494             |      |      |         | 946     |      |      |         | 888     |     
|                                      |                       |                         |                                               |                   |      |      |         |         |      |      |         |        
|                                      |                       |                         |                                               | Adjusted net loss |      | $    | (18,087 | )       |      | $    | (15,840 | )       |      | $    | (9,117 | )
|                                      |                       |                         |                                               |                   |      |      |         |         |      |      |         |        
|Basic and diluted net loss per share: |                       |                         |                                               |                   |      |      |         |         |      |      |         |        
|                                      |                       | Reported loss per share |                                               | $                 | (.99 | )    |         | $       | (.99 | )    |         | $       | (.87 | )   
|                                      |                       | Goodwill amortization   |                                               |                   | .07  |      |         |         | .06  |      |         |         | .06  |     
|                                      |                       |                         |                                               |                   |      |      |         |         |      |      |         |        
|                                      |                       |                         | Adjusted basic and diluted
net loss per share |                   | $    | (.92 | )       |         | $    | (.93 | )       |         | $    | (.81 | )     
|                                      |                       |                         |                                               |                   |      |      |         |         |      |      |         |        

Excluded from the
adjusted net loss and related adjusted basis and diluted net loss per
share in 2001 was a goodwill impairment charge of $7,640.

Goodwill and other intangibles are as follows:

|                    |  |               |        |                   |  |          |       |          |  |              |       |          |  |   |       |  |  |   |       |  |  |   |       | 
|------------------- |  | ------------- | ------ | ----------------- |  | -------- | ----- | -------- |  | ------------ | ----- | -------- |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                    |  | June 30, 2002 |        | December 31, 2001
|                    |  |               |        |                  
|                    |  | Gross         |        | Accumu-           |  | Net      |       | Gross    |  | Accumu-      |       | Net     
|                    |  | Carrying      |        | lated             |  | Carrying |       | Carrying |  | lated        |       | Carrying
|                    |  | Amount        |        | Amortization      |  | Amount   |       | Amount   |  | Amortization |       | Amount  
|                    |  |               |        |                   |  |          |       |          |  |              |       |         
|Goodwill            |  | $             | 3,310  |                   |  | $        | 433   |          |  | $            | 2,877 |          |  | $ | 3,310 |  |  | $ | 433   |  |  | $ | 2,877 | 
|Acquired Technology |  |               | 8,790  |                   |  |          | 3,584 |          |  |              | 5,205 |          |  |   | 6,300 |  |  |   | 3,116 |  |  |   | 3,184 | 
|                    |  |               |        |                   |  |          |       |          |  |              |       |          |  |   |       |  |  |   |       |  |  |   |       | 
|                    |  | $             | 12,100 |                   |  | $        | 4,017 |          |  | $            | 8,083 |          |  | $ | 9,610 |  |  | $ | 3,549 |  |  | $ | 6,061 | 
|                    |  |               |        |                   |  |          |       |          |  |              |       |          |  |   |       |  |  |   |       |  |  |   |       | 

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (Statement 146). Statement 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities. This statement supersedes Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. Click2learn is required to adopt Statement 146 no
later than January

8



---



##### Table of Contents



1, 2003 and the accounting and reporting for exit and disposal activities
will be impacted on a prospective basis.

Segment Information

Click2learns internal reporting includes three reportable segments:
Platforms, Tools, and Content Services. Platforms includes software licenses,
subscription and hosting fees, implementation, customization, training and support for the
Aspen Enterprise Learning Platform as well as the Ingenium learning management
system which is now part of the Aspen platform, and the e-Learning Network,
which is no longer offered to new customers. Tools includes software
licenses, technical support and training for ToolBook II product line. Content
Services includes custom development of e-Learning courses, consulting,
licensing, implementation and hosting fees for ReDS, a content development system that is no
longer offered, and royalties from sales of third party content.

Click2learns operating committee, which includes its Chief Executive
Officer and Chief Financial Officer, has been identified as the Chief Operating
Decision Maker (CODM) as it assesses the performance of the business units
and decides how to allocate resources to the business units. Segment income is
the measure of profit and loss that the CODM uses to assess performance and
make decisions. Segment income represents revenues less cost of revenues
incurred within the operating segments as presented in Click2learns
consolidated statements of operations. Click2learn does not allocate operating
expenses including research and development, sales and marketing, general and
administrative, or amortization of goodwill to its operating segments. In
addition, other income (expense) is also not allocated to operating segments.

There are no intersegment revenues. Click2learns CODM does not review
total assets or depreciation and amortization by operating segment. The
accounting policies for reported segments are the same as for Click2learn as a
whole.

Revenues by geographic region which are based on the location of the
customers are as follows (in thousands):

|         |                                  |   |               |       |              |   |        |        |      |   |        |        |  |   |        |        | 
|-------- | -------------------------------- | - | ------------- | ----- | ------------ | - | ------ | ------ | ---- | - | ------ | ------ |  | - | ------ | ------ | 
|         |                                  |   | For the Three |       | For the Six 
|         |                                  |   | Months Ended  |       | Months Ended
|         |                                  |   | June 30,      |       | June 30,    
|         |                                  |   |               |       |             
|         |                                  |   | 2002          |       | 2001         |   | 2002   |        | 2001
|         |                                  |   |               |       |              |   |        |        |     
|Revenue: |                                  |   |               |       |              |   |        |        |      |   |        |        |  |   |        |       
|         | Domestic                         |   | $             | 6,943 |              |   | $      | 10,760 |      |   | $      | 13,682 |  |   | $      | 20,364 | 
|         | International  primarily Europe |   |               | 686   |              |   |        | 936    |      |   |        | 1,478  |  |   |        | 1,986  | 
|         |                                  |   |               |       |              |   |        |        |      |   |        |        |  |   |        |       
|         |                                  | $ | 7,629         |       |              | $ | 11,696 |        |      | $ | 15,160 |        |  | $ | 22,350 |       
|         |                                  |   |               |       |              |   |        |        |      |   |        |        |  |   |        |       

Long-lived assets by geographic location are as follows (in thousands):

|                  |                                  |   |          |       |              |   |       |       | 
|----------------- | -------------------------------- | - | -------- | ----- | ------------ | - | ----- | ----- | 
|                  |                                  |   | June 30, |       | December 31,
|                  |                                  |   |          |       |             
|                  |                                  |   | 2002     |       | 2001        
|                  |                                  |   |          |       |             
|Long-lived assets |                                  |   |          |       |              |   |       |      
|                  | Domestic                         |   | $        | 9,548 |              |   | $     | 8,081 | 
|                  | International  primarily Europe |   |          | 125   |              |   |       | 230   | 
|                  |                                  |   |          |       |              |   |       |      
|                  |                                  | $ | 9,673    |       |              | $ | 8,311 |      
|                  |                                  |   |          |       |              |   |       |      

9



---



##### Table of Contents



Sale of Certain Assets and Employee Severance and Loss on Excess Facilities

During January 2002, Click2learn sold certain assets of its custom content
development business, including equipment and a customer list, to NIIT (USA),
Inc. (NIIT) under an Asset Purchase Agreement for $1 million, resulting in a
gain of $927,000 based on the book value of the assets. As a result of the
transaction, NIIT will be Click2learns primary strategic partner for custom
content development services. If certain targets for the referral of custom
content development business to NIIT are attained, NIIT will pay Click2learn up
to an additional $1 million in each of 2002 and 2003. In addition, Click2learn
receives a commission on certain custom content development or software
implementation business referred to NIIT.

As a result of the transaction with NIIT, Click2learn significantly
reduced the headcount of its custom content development business and closed
certain facilities. During the six months ended June 30, 2002, Click2learn had
employee severance and excess facilities costs of $1.1 million, which included
$196,000 of severance benefits, $270,000 to write-down leasehold improvements
to net realizable value and $672,000, representing the excess of our future
lease commitments over estimated income from subleasing activities. As of June
30, 2002, all employee severance benefits had been paid and
$315,000 was
included in accrued expenses for the loss on excess office facilities.
Although, Click2learn believes that its estimates of future sublease income and
the time required to locate tenants are reasonable, losses may increase if
actual experience differs from Click2learns estimates.

Subsequent Events

In July 2002, Click2learn decided to
voluntarily terminate its custom content
development agreement related to the Washington National Guard. As of June 30, 2002,
Click2learn was owed approximately $5.0 million related to
ongoing custom
content development projects which it believes would be collectable
if all remaining work were completed under the contract. It is
possible that Click2learn may incur off-setting obligations as a
result of its decision to terminate the agreement or that some or all
of the receivable may not ultimately be collected. Click2learn is currently negotiating the terms
of terminating the agreement and transitioning certain of its employees to
other contractors who may continue projects in process. The results of these
negotiations cannot yet be determined. Click2learn expects that it will exit
its remaining custom content development business through a run-off of
operations which will be completed in either the third or fourth quarter of
2002.

10



---



##### Table of Contents






Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations

The following discussion of the financial condition and results of
operations of Click2learn should be read in conjunction with Click2learns
Condensed Consolidated Financial Statements and related Notes thereto included
elsewhere in this Report. This Report and the documents incorporated herein by
reference include forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. This Act provides a safe
harbor for forward-looking statements to encourage companies to provide
prospective information about themselves so long as they identify these
statements as forward-looking and provide meaningful cautionary statements
identifying important factors that could cause actual results to differ from
the projected results. All statements other than statements of historical fact
we make in this Report are forward-looking. Such forward-looking statements
involve risks and uncertainties, including, among other things, statements
regarding our anticipated costs and expenses and revenue mix. Such
forward-looking statements include, among others, those statements including
the words expect, anticipate, intend, believe and similar language. Our
actual results may differ significantly from those projected in the
forward-looking statements. Factors that might cause or contribute to such
differences include, but are not limited to those discussed in Factors That
May Affect Future Results of Operations. You are cautioned not to place undue
reliance on the forward-looking statements, which speak only as of the date of
this Quarterly Report on Form 10-Q. We undertake no obligation to publicly
release any revisions to the forward-looking statements or reflect events or
circumstances after the date of this document.

Overview

We are a leading developer and provider of enterprise learning software
products and services for companies, government agencies and educational
institutions. We design, develop, market, license and support an integrated
suite of enterprise learning software products and related services that allow
our customers to cost-effectively create, personalize and manage the delivery
of educational content. In the third quarter of 2001, we introduced our new
Aspen platform that unifies collaborative content development, personalized
content delivery and comprehensive learning management in an integrated system
designed to be open, flexible and scalable. We provide our enterprise learning
products and services to customers across a broad range of industries including
financial services, accounting, healthcare, insurance, technology,
manufacturing, telecommunications, transportation, utilities, government and
education.

We report revenues around the primary components of our solutions:



| |  |  | Platforms revenues include software licenses, subscription
and hosting fees, implementation, customization, training and
support related to the Aspen platform, our Ingenium learning
management system, the precursor product to the Aspen Learning
Management Server, and our e-Learning Network, which is no longer
offered to new customers.                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Tools revenues primarily include software licenses, technical
support and training related to our ToolBook II line of products.                                                                                                                                                                                                                                                                        
|
| |  |  | Content Services revenues are derived from the creation of
custom learning content, consulting, fees for licensing,
implementing and hosting our Rapid e-Learning Development System
(ReDS), and sales of third party
off-the-shelf content. ReDS is a collaborative development system
that was licensed in connection with certain custom content
development engagements and is no longer offered.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are as follows:



| |  |  | Revenue recognition                                                            
| | - |  | -------------------------------------------------------------------------------
|
| |  |  | Estimating allowances for sales returns and the allowance for doubtful accounts

11



---



##### Table of Contents





| |  |  | Valuation of goodwill
| | - |  | ---------------------

Revenue Recognition.We recognize revenue pursuant to the requirements of
Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2), as
amended by Statement of Position No. 98-9, Software Revenue Recognition with
Respect to Certain Arrangements. Under SOP 97-2, revenue attributable to an
element in a customer arrangement is recognized when persuasive evidence of an
arrangement exists and delivery has occurred, provided the fee is fixed or
determinable, collectibility is probable and the arrangement does not require
significant customization of the software.

For all sales, we use either a binding purchase order or signed agreement,
depending on the nature of the transaction, as evidence of an arrangement.
Sales through our significant resellers are evidenced by a master agreement
governing the relationship.

For software license fees in single element arrangements and multiple
element arrangements which do not include customization or consulting services,
delivery typically is deemed to occur when the product is shipped to customers.

At the time of each transaction, we assess whether the fee associated with
our revenue is fixed and determinable and whether or not collection is
reasonably assured. We assess whether the fee is fixed and determinable based
on the payment terms associated with the transaction. If a significant portion
of a fee is due after our normal payment terms, based upon a variable matrix
such as a minimum level of distribution or subject to refund, we account for
the fee as not being fixed and determinable. In these cases, we defer revenue
and recognize it when it becomes due and payable.

We assess the probability of collection based on a number of factors,
including past transaction history with the customer and the current financial
condition of the customer. We do not request collateral from our customers. If
we determine at the time of the transaction that collection of a fee is not
reasonably assured, we defer revenue until the time collection becomes
reasonably assured.

For multiple element
arrangements, when company-specific objective
evidence of fair value exists for all of the undelivered elements of the
arrangement, but does not exist for one or more of the delivered elements in
the arrangement, we recognize revenue under the residual method. Under the
residual method, at the outset of the arrangement with a customer, we defer
revenue for the fair value of its undelivered elements such as consulting
services and product support and upgrades, and recognize the revenue for the
remainder of the arrangement fee attributable to the elements initially
delivered, such as software licenses, when the criteria in SOP 97-2 have been
met. Company-specific objective evidence is established for support and
upgrades of standard products for which no installation or customization is
required based upon the amounts we charge when support and upgrades are sold
separately. For multiple element arrangements involving installation or
customization, company-specific objective evidence is established for support
and maintenance arrangements if our customers have an optional annual renewal
rate specified in the arrangement and the rate is substantive. Company-specific
objective evidence is established for consulting and installation services
based on the hourly rates we charge for our employees when they are performing
these services provided we have the ability to accurately estimate the hours
required to complete a project based upon our experience with similar projects.

Professional services revenue is recognized from fixed price contracts as
services are provided or by using the percentage-of-completion method of
accounting, based on the ratio of costs incurred to the total estimated project
cost, for individual fixed-price contracts. Provisions for any estimated losses
on uncompleted contracts are made in the period in which such losses become
evident. Professional services revenue from time and materials contracts and
training services is recognized as revenue as services are performed.

We recognize revenue from non-refundable minimum royalty agreements from
distributors or resellers upon delivery of product to the distributor or
reseller, provided no significant obligations remain outstanding and the
conditions of SOP 97-2 have been met. Additional royalties are recognized as
revenue to the extent the minimums are exceeded when earned, based on the
distributors or resellers contractual reporting obligations.

12



---



##### Table of Contents



Revenue from subscription licenses, hosting agreements and support
agreements is recognized on a straight-line basis over the life of the
contract.

Allowances for Sales Returns and Doubtful Accounts.The preparation of
financial statements requires us to make estimates and assumptions that affect
the reported amount of assets and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reported period. Specifically, we must make
estimates of potential future product returns related to current period product
revenue. We analyze historical returns, current economic trends, and changes in
customer demand and acceptance of our products when evaluating the adequacy of
the sales returns and other allowances. Significant judgments and estimates
must be made and used in connection with establishing reserves for sales
returns and the allowance for doubtful accounts in any accounting period.
Material differences may result in the amount and timing of our revenue for any
period if we made different judgments or utilized different estimates.
Similarly, we must make estimates of the uncollectability of our accounts
receivables. We specifically analyze the age of accounts receivable and analyze
historical bad debts, customer concentrations, customer credit-worthiness and
current economic trends when evaluating the adequacy of the allowance for
doubtful accounts.

Valuation of Goodwill.We assess the impairment of goodwill on an annual
basis or whenever events or changes in circumstances indicate the fair value of
a reporting unit to which goodwill relates is less than its carrying value.
Factors we consider important which could trigger an impairment review include
poor economic performance relative to expected historical or projected future
operating results, significant negative industry, economic or company specific
trends and changes in the manner of our use of the assets or the plans for our
business. If we were to determine that the fair value of a reporting unit was
less than its carrying value, including goodwill based upon the annual test or
the existence of one or more of the above indicators of impairment, than we
would measure impairment based on a comparison of the implied fair value of
reporting unit goodwill with the carrying amount of goodwill. The implied fair
value of goodwill is determined by allocating the fair value of a reporting
unit to its assets (recognized and unrecognized) and liabilities in a manner
similar to a purchase price allocation. The residual fair value after this
allocation is the implied fair value of reporting unit goodwill. To the extent
the carrying amount of reporting unit goodwill is greater than the implied fair
value of reporting unit goodwill, we would record an impairment charge for the
difference.

Three and Six Months Ended June 30, 2002 Compared to Three and Six Months Ended
June 30, 2001

Revenue. Total
revenues were $7.6 million and $15.2 million for the three
and six months ended June 30, 2002, down 35% and 32% as compared
to $11.7 and $22.4 million for the three and six months ended
June 30, 2001. These results reflect higher
Platform revenues, offset by declines in Tools and Content Services
revenues. We believe the Aspen platform offers the greatest
opportunity for growth in the coming periods and therefore have
decided to focus our sales and R&D efforts primarily on the Aspen
platform. The Tools segment, while complementary to the Aspen
platform, does not and will not receive the same level of sales and
R&D focus it has had in prior periods. The Content Services
segment has decreased as a result of our decision to discontinue
providing custom content development services, which will be
completed with the transition of our contract to develop content for
the Washington National Guard. As a result, we expect that the
Platforms segment will be our primary growth segment for the
foreseeable future and that the Tools and Content Services segments
will continue to decline.

Platform revenue was $5.5 million for
the quarter ended June 30, 2002, an increase of 19% from
$4.6 million for the
quarter ended June 30, 2001. Platform revenue was $10.9 million for the six
months ended June 30, 2002, an increase of 43% from
$7.6 million for the six months
ended June 30, 2001. The increase for the three and six month periods in
Platform revenues is attributed to increased demand for our Aspen suite of products and
related services.

Tools revenues were $1.2 million and $2.5 million for the three and six
month periods ended June 30, 2002, down 32% and 35% as compared to $1.8
million and $3.8 million for the three and six month periods ended June 30,
2002, reflecting the focus of sales and R&D resources on the
Aspen platform.

Content Services
revenues were $875,000 and $1.7 million for the three and six
month periods ended June 30, 2002, down 83% and 84% from
$5.3 million and $10.9 million for the three and six month
periods ended June 30, 2001, reflecting the moves taken to exit the content development business. We expect the content
development business to be completed in the third or fourth quarter
of 2002 through a runoff of operations.

In July 2002, we
announced that we had voluntarily chosen to seek an end to our
contract under which we
produce custom content for the Washington National Guard. We made
this decision because this business did not align with our long term strategic
decision to focus the companys efforts on the Aspen platform
and related services. We are currently negotiating the terms of the
transition with the Washington National Guard and with Information
Systems Support, Inc., the prime contractor. We expect that this
transition will be completed by the end of September 2002. Combined with the sale to NIIT in January 2002 of the
commercial portion of our custom content development business, the termination
of this contract will mark the discontinuation of our custom content
development business. For purposes of comparison, custom content development
revenue is and has been the primary contributor of revenue reported under the
Content Services category. For the three and six month periods ended June 30,
2001 custom content was $4.3 million and $9.0 million or over 80% of the
revenue reported under Content Services.

13



---



##### Table of Contents



Cost of Revenue.Cost of revenue of $3.1 million and $7.3 million for the
three and six months ended June 30, 2002 decreased 47% and 40% from $5.9
million and $12.2 million for the three and six months ended
June 30, 2001. Cost as a percentage of revenue decreased from
50% to 41% for the three months ended June 30, 2002 compared to
the three months ended June 30, 2001, and decreased from 54% to
48% for the six months ended June 30, 2002 compared to the six
months ended June 30, 2001. The decline is a result of the reduction of our custom development business
that historically has been a lower margin business as compared to the software
sales.

Cost of Platforms
revenue includes labor costs associated with software
implementations, costs of packaging and duplication. Cost of
Platforms revenue of $1.5 million and $3.1 million for the
three and six months ended June 30, 2002 increased 89% and 112%
as compared to $784,000 and $1.4 million for the three and six
months ended June 30, 2001. Cost as a percentage of revenue
increased from 17% to 27% for the three months ended June 30,
2002 compared to the three months ended June 30, 2001, and
increased from 19% to 28% for the six months ended June 30, 2002
compared to the six months ended June 30, 2001. The increased
costs are a result of higher Platform revenues and the personnel cost
of larger services engagements to implement these systems.

Cost of Tools revenue
includes labor costs associated with training Toolbook customers,
costs of packaging, duplication and royalties. Cost of Tools revenue
of $287,000 and $682,000 for the three and six months ended
June 30, 2002 decreased 36% and 27% from $450,000 and $936,000
for the three and six months ended June 30, 2001. The decline is
due to reduced Tools revenues resulting from the focus of our efforts
on the Aspen platform. Cost as a percentage of revenue was relatively
flat, decreasing slightly from 25% to 23% for the three months ended
June 30, 2002 compared to the three months ended June 30,
2001, and increasing slightly from 24% to 27% for the six months
ended June 30, 2002 compared to the six months ended
June 30, 2001.

Cost of Content
Services revenue includes personnel costs for professional services
provided and royalties on sales of third party content. Cost of
Content Services revenue of $1.3 million and $3.5 million
for the three and six months ended June 30, 2002 declined 71%
and 64% from $4.7 million and $9.8 million for the three
and six months ended June 30, 2001. Cost as a percentage of
revenue increased from 88% to 152% for the three months ended
June 30, 2002 compared to the three months ended June 30,
2001, and increased from 90% to 205% for the six months ended
June 30, 2002 compared to the six months ended June 30,
2001. The decrease in costs and increase in costs as a percentage of
revenue are a result of the phase out of our custom development
business.

Operating Expenses

Research and Development.Research and development costs of $2.4 million
and $4.7 million for the three and six months ended June 30, 2002 increased 12%
and 5% from $2.1 million and $4.5 million for the three and six months ended
June 30, 2001. Research and development costs are primarily salaries and
facility costs related to personnel who develop the Aspen platform. The
increase was due to increased staff added to the Aspen development
team. We do not anticipate adding additional staff to the Aspen
development for the remainder of 2002.

Sales and Marketing.Sales and marketing costs of $4.8 million and $9.3
million for the three and six months ended June 30, 2002 decreased 3% and 4%
from $5.0 million and $9.7 million for the three and six months ended June 30,
2001. Sales and marketing costs consist primarily of salaries, commissions and
promotional programs. The decline was a result of lower variable sales
costs. In July, we reduced sales and marketing headcount and the
budget for promotional programs and as a result we expect that the
sales and marketing expenses will be lower for the remainder of
2002.

General and Administrative.General and Administrative costs of $1.4
million and $3.5 million for the three and six months ended June 30, 2002
declined 10% for the three month period and increased 8% for the six month
period as compared to $1.6 million and $3.2 million for the three and six
months ended June 30, 2001. General and Administrative costs consist primarily
of salaries, state taxes, bad debt expenses and facility related costs. The
decline in the three months ended June 30, 2002 was due to lower headcount.
The increase for the six months resulted from transition costs associated with
the sale of our commercial custom development assets to NIIT.
In July 2002, we reduced general and administrative headcount and as a
result of that reduction and the discontinuance of our custom content
development business, we expect that general and administrative
expenses will be lower for the remainder of 2002.

Amortization of Goodwill.Goodwill amortization was $0 for the three and
six months ended June 30, 2002 as compared to $312,000 and $551,000 for the
three and six months ended June 30, 2001. As of January 1, 2002, we adopted
Statement 142 which requires that goodwill is no longer amortized, but subject
to an annual impairment test.

Other Income. Interest income, net, on cash and cash equivalents for the
three months ended June 30, 2002

14



---



##### Table of Contents



was ($3,000) and $22,000 as compared to $83,000 and $255,000 for the three
and six months ended June 30, 2001. The decrease was due to lower interest
rates and lower investment balances. Click2learn Japan K.K. is a joint venture which we
account for our interest using the equity method of accounting. We recorded a
loss of $75,000 and $100,000 for the quarters ended June 30, 2002 and 2001,
respectively, representing our equity share of losses. For the six months
ended June 30, our share of the net losses of Click2learn Japan, K.K. were
$150,000 and $200,000 for 2002 and 2001, respectively.

Sale of Certain Assets and Employee Severance and Loss on Excess Facilities

During January 2002, we sold certain assets of our content development
business, including equipment and a customer list to NIIT under an Asset
Purchase Agreement for $1 million, resulting in a gain of $927,000 based on the
book value of those assets during the six months ended June 30, 2002. As a
result of the transaction, NIIT will be our primary strategic partner for
custom content development services and we will refer or subcontract custom
content development work to NIIT. If certain targets are attained, NIIT will
pay us up to $1 million additional in each of 2002 and 2003. In addition, we
will receive a commission on certain business referred to NIIT.

As a result of the transaction with NIIT, we significantly reduced the
headcount of our custom content development business and closed certain
facilities. During the six months ended June 30, 2002, we had employee
severance and excess facilities costs of $1.1 million, which included $196,000
of severance benefits, $270,000 to write-down leasehold improvements to net
realizable value and $672,000, representing the excess of our future lease
commitments over estimated income from subleasing activities. As of June 30,
2002, all employee severance benefits had been paid and $315,000 was included
in accrued expenses for the loss on excess office facilities. Although we
believe that our estimates of future sublease income and the time required to
locate tenants are reasonable, losses may increase if actual experience differs
from our estimates.

Adoption of Accounting Standards

In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations (Statement
141), and No. 142, Goodwill and Other Intangible Assets (Statement 142).
Statement 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 as well as all purchase
method business combinations completed after June 30, 2001. Statement 141 also
specifies certain criteria that intangible assets acquired in a purchase method
business combination must meet in order to be recognized and reported apart
from goodwill. Statement 142 requires that goodwill and intangible assets with
indefinite useful lives no longer be amortized, but instead tested for
impairment at least annually in accordance with the provisions of Statement
142. Statement 142 also requires that intangible assets with definite useful
lives be amortized over their respective estimated useful lives to their
estimated residual values. The provisions of Statement 141 were adopted
effective July 1, 2001. No business combinations were completed during the
period July 1, 2001 to June 30, 2002. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 have been amortized
through December 31, 2001.

As of January 1, 2002, we have identified intangible assets, consisting of
acquired technology and goodwill, net of accumulated amortization. Upon
adoption of Statement 142, we ceased amortizing goodwill. During the quarter
ended March 31, 2002, we completed our transitional goodwill impairment test.
Based upon our analysis, there was no impairment of goodwill upon adoption of
Statement 142 on January 1, 2002. We plan to conduct our annual impairment
testing during the fourth quarter of each year. In addition, we reviewed the
useful lives of our identifiable intangible assets and determined that the
original estimated lives of 3 to 5 years remains appropriate.

In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting of the Impairment or Disposal of Long-Lived
Assets (Statement 144), which is effective for fiscal years beginning after
December 15, 2001. Statement 144 supersedes certain provisions of APB Opinion
No. 30, Reporting the Results of Operations  Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual, and
Infrequently Occurring Events and Transactions and supersedes SFAS 121. We
adopted Statement 144 as of January 1, 2002. Adoption of Statement 144 did not
effect our consolidated financial position or results of operations

15



---



##### Table of Contents



as of January 1, 2002.

Recent Accounting Pronouncements

In June 2002, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards Board No. 146, Accounting for Costs Associated
with Exit or Disposal Activities (Statement 146). Statement 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities. This statement supersedes Emerging Issues Task Force Issue No.
94-3, Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity. We are required to adopt Statement 146 no later
than January 1, 2003 and the accounting and reporting for exit and disposal
activities will be impacted on a prospective basis.

Liquidity and Capital Resources

At June 30, 2002, our principal source of liquidity was $10.0 million of
working capital, a decrease of $10.9 million from December 31, 2001. At June
30, 2002, we had cash and cash equivalents totaling $ 5.0 million, a decrease
of $4.6 million from December 31, 2001.

In addition to our cash and cash
equivalents, the other primary component of working capital was our accounts
receivable. At June 30, 2002, we had $13.9 million in accounts receivables,
down from $19.4 million at December 31, 2001, due to decreased revenues and
improved collection efforts.

Cash used for
operations for the six months ended June 30, 2002 was
$3.3 million. In July and August of 2002 we took steps to reduce
our expected uses of cash for the remainder of 2002. As a result, we anticipate that we will use
$1.4 million of cash for operations in the third quarter for
severances and other costs related to the expense reductions, but
that overall our uses of cash for operations for second half of 2002
will be minimal. In order to reduce operational cash requirements we
have enacted a mixture of staff and expense reductions as well as
taken steps to end our service arrangement whereby we develop
custom content for the Washington National Guard which has had long
payment cycles. Most work under this contract is required to be billed
upon completion of curriculum that typically takes several months
to develop. We anticipate voluntarily terminating our custom content
development agreement related to the Washington National Guard. As of
June 30, 2002, we were owed approximately $5.0 million for
projects in process. We are currently negotiating the terms of
terminating the agreement and transitioning certain of our employees
to other contractors who may continue projects in process. Although
we do not yet know the outcome of these negotiations, we believe the
receivable would be collectable if all remaining work were completed
under the contract. It is possible that we may incur off-setting
obligations as a result of our decision to terminate the agreement or
that some or all of the receivable may not ultimately be collected.

Uses of cash for
investing activities were $1.9 million offset by $567,000
received from
financing activities for the six months ended June 30, 2002.
Uses of cash for investing activities consisted primarily of the
purchase of technology for $2.7 million offset
by $1.0 million for assets sold to NIIT. We do not anticipate
any significant uses of cash for investing activities in the second
half of 2002.

The steps we have
taken to reduce operating expenses for the second half of 2002 are
intended to minimize or eliminate the need for any type of financing
activities by moving us to a cash flow positive level of operations
at currently expected revenue levels and revenue mix. We will
continue to monitor our cash and liquidity and will seek additional
financing or make additional expense reductions if it becomes
required.

In order to increase the liquidity of our receivables, we have established
a $4 million working capital line of credit and a two-year $1 million term loan
facility for purchases of capital assets with Silicon Valley Bank. Both lines
bear interest at the Silicon Valley Bank prime rate plus 1.50% and are
collateralized by our assets. Covenants in the loan agreements include
restrictions on our ability to pay dividends or make other distributions, make
acquisitions or investments, merge or consolidate with others or dispose of
assets. If not renewed the working capital line terminates and any advances
made are due on November 5, 2002. The term loan is payable in 24 monthly
payments of $41,666.67 plus interest ending October 1, 2003. At June 30, 2002,
we had a combined balance of $1,067,000. Our loan agreement requires us to maintain certain
financial ratios and meet other financial covenants. The failure to meet those
covenants could prevent us from accessing the working capital line and result
in the acceleration of any balances under either the working capital line or
the term loan. We were in compliance with these covenants at
June 30, 2002 or have obtained appropriate waivers from the bank at no cost to
us. We anticipate consolidating the two loan facilities into a
$5 million working capital line by the end of October 2002.

Our long-term liquidity will be affected by numerous factors,
including economic conditions, both generally and in the market for
enterprise learning software, demand for our Aspen platform, Aspen
platform sale cycles, the
extent to which our enterprise learning solutions achieve market acceptance,
the timing and extent to which we invest in new technology, the expenses of
sales and marketing and new product development, the extent to which
competitors are successful in developing their own products and services and
increasing their own market share, the level and timing of revenues, the
collection of these receivables, the availability of our lines of credit and
other factors.

To the extent that resources are insufficient to fund our activities, we
may need to raise additional funds. Such additional funding, if needed, may not
be available on attractive terms or at all. If adequate funds are not available
on acceptable terms, we may be unable to expand our business, develop or
enhance our products and services, take advantage of future opportunities or
respond to competitive pressures, any of which could have a material adverse
effect on our business.

Our contractual commitments at June 30, 2002 are substantially similar to
those at December 31, 2001 disclosed in our annual report on Form 10-K.

Factors That May Affect Future Results of Operations

Our quarterly operating results are uncertain and may fluctuate significantly,
which could negatively affect the

16



---



##### Table of Contents



value of your investment.

Our operating results are difficult to predict accurately and have varied
significantly from quarter to quarter and are likely to continue to fluctuate
as a result of a variety of factors, many of which we cannot control. Factors
that may adversely affect our quarterly operating results include:



| |  |  | the size and timing of product orders and the timing and
execution of professional services engagements;                                                                                                                             
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the mix of revenue from products and services;                                                                                                                                                                                       
|
| |  |  | the mix of products sold;                                                                                                                                                                                                            
|
| |  |  | the ability to meet client project milestones;                                                                                                                                                                                       
|
| |  |  | the market acceptance of our products and services;                                                                                                                                                                                  
|
| |  |  | our ability to develop and market new or enhanced products
and services in a timely manner and the market acceptance of these
products and services;                                                                                 
|
| |  |  | the timing of revenues and expenses;                                                                                                                                                                                                 
|
| |  |  | recognition of impairment of
existing assets, in particular the amount of the write-off resulting
from our decision to exit the custom content development business and
termination agreement with the
Washington National Guard; and
|
| |  |  | the timing of revenue recognition.                                                                                                                                                                                                   

Our future revenues are difficult to predict and we may not be able to
adjust spending in response to revenue shortfalls. Our limited operating
history with our current enterprise learning solutions, possible acquisitions
and the emerging nature of the enterprise learning market make prediction of
future revenue and expenses difficult. Expense levels are based, in part, on
expectations as to future revenue and largely are fixed in the short term. We
will likely be unable to, or may not elect to, reduce spending quickly enough
to offset any unexpected revenue shortfall. If we are unable to predict future
revenue accurately, we may be unable to adjust spending in a timely manner to
compensate for any unexpected revenue shortfall.

Our business currently does not generate the cash needed to finance our
operations, and for that and other reasons we may need additional financing in
the future, which we may be unable to obtain.

Our business currently does not generate the cash needed to finance our
operations and may not begin to do so in 2002. As a result, we may need
additional funds to finance our operations in the future as well as to enhance
our products and services, fund our expansion, respond to competitive pressures
or acquire complementary businesses or technologies. In addition, poor
financial results, additional expenses or unanticipated opportunities that
require capital commitments could give rise to additional financing
requirements sooner than we expect. We may be unable to obtain financing on
terms favorable to us, or at all. If adequate funds are not available or are
not available on acceptable terms, we may be unable to finance our operations,
enhance our services, fund our expansion, respond to competitive pressures or
take advantage of business opportunities. We have taken steps to restrict our
operations in order to conserve our existing cash and we may need to further
significantly restrict our operations in the future.

A deterioration of general economic conditions may materially and adversely
affect our business.

Our revenues are subject to fluctuation as a result of general economic
conditions. A significant portion of our revenue is derived from the sale of
products and services to large companies or government agencies, which
historically have reduced their expenditures for enterprise software
applications during economic downturns. In recent quarters, our sales force has
experienced increased delays, cancellations or reductions in scope of sales
opportunities as a result of the downturn in the economy. Should the economy
weaken further in any future period,

17



---



##### Table of Contents



these organizations may further delay, cancel, or reduce their
expenditures on enterprise software applications, which could adversely affect
our business.

We have a history of losses and may have continued losses in the future.

We incurred a net loss of approximately $4.2 million in the three months
ended June 30, 2002. As of June 30, 2002, our accumulated deficit was $221.8
million. We have not yet achieved profitability and may not do so during 2002.
Even if we do achieve profitability, we may be unable to sustain or increase
profitability on a quarterly or annual basis.

We have a limited operating history in our current markets, which makes it
difficult to predict our future performance.

Our limited operating history in our current markets makes it difficult to
predict our future performance and may not provide investors with a meaningful
basis for evaluating an investment in our common stock. From our inception
until early 1995, we were engaged in various research and development
activities and in developing and marketing multimedia-authoring products,
database and Internet tools, web publishing products and other ancillary
products, most of which we do not currently sell. In 1995, we began to focus
our development and marketing efforts on products and services for the
enterprise learning market. We released the Aspen platform in September 2001.
Accordingly, we have a limited operating history on which to evaluate our
current business and future prospects.

The enterprise learning software market is in the early stages of development
and may not grow to a sufficient size or at a sufficient rate to sustain our
business.

The enterprise learning software market is in the early stages of
development, and may not grow to a sufficient size or at a sufficient rate for
our business to succeed. Corporate training and education historically have
been conducted primarily through classroom instruction. Although
technology-based training applications have been available for several years,
they currently account for only a small portion of the overall corporate
learning market. Accordingly, our success will depend on the extent to which
companies implement enterprise learning software solutions for the design,
development, delivery and management of their corporate learning needs.

Many companies that have already invested substantial resources in
traditional training methods may be reluctant to adopt a new strategy that may
limit or compete with their existing investments. Even if companies implement
enterprise learning software solutions, they may still choose to develop such
solutions internally. If the use of enterprise learning software does not
become widespread or if companies choose to develop such software internally
rather than acquiring it from third parties, then our enterprise learning
software may not be commercially successful.

We face risks encountered in emerging markets and may be unsuccessful in
addressing these risks.

We face risks frequently encountered in new and rapidly evolving markets.
Specific risks we face relate to the demand for and market acceptance of our
enterprise learning solutions. We may fail to adequately address these risks,
and therefore our business may suffer. To address these risks, we must:



| |  |  | effectively market our enterprise learning software to new and existing customers;                                                  
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | continue to enhance the technology upon which our enterprise learning software is based;                                            
|
| |  |  | successfully implement our enterprise learning software for
our customers and generate continuing revenues from those customers;
and
|
| |  |  | address and establish new technologies and technology
standards.                                                                    

We face intense competition from other enterprise learning software providers
and may be unable to compete

18



---



##### Table of Contents



successfully.

The enterprise learning software market is highly fragmented and
competitive, with no single firm accounting for a dominant market share. Our
competitors vary in size, scope and the breadth of products and services
offered. We face competition from:



| |  |  | other developers of enterprise learning systems, such as Saba and Docent;
| | - |  | -------------------------------------------------------------------------
|
| |  |  | large professional consulting firms and in-house IT departments; and     
|
| |  |  | developers of web authoring tools.                                       

Certain of our existing and potential competitors have longer operating
histories and significantly greater financial, technical, marketing and other
resources and therefore may be able to respond more quickly to new or changing
opportunities, technologies, standards and customer requirements or to compete
more aggressively on pricing. Price competition would likely result in reduced
gross margins and may prevent the Aspen platform from yielding results
sufficient for our business to succeed.

Strategic relationships are important in expanding the distribution reach
of companies in the enterprise learning market. If our competitors were to
establish strategic relationships to resell or distribute their products
through their strategic partners, our ability to market and sell products and
services successfully may be substantially diminished. In addition, the
existence or announcement of strategic relationships involving our competitors
could adversely affect our ability to attract and retain customers.

Because of the lack of significant barriers to entry in the enterprise
learning market, new competitors are likely to enter this market in the future.
In particular, vendors of other enterprise software applications such as
enterprise resource planning, human resource management or customer
relationship management have indicated an intent to add learning delivery and
management functionality to extend their current product lines within their
existing customer base. If such vendors were to announce plans to add such
functionality, our ability to sell our products and service to their
customers could be substantially diminished and our business could be adversely
affected. Increased competition is likely to result in price reductions,
reduced gross margins and loss of market share. We may not be able to contend
effectively with such increased competition.

The loss of the services of our senior executives and key personnel would
likely cause our business to suffer.

Our success depends to a significant degree on the performance of the
senior management team and other key employees. The loss of any of these
individuals could harm our business. We do not have employment agreements with
several of our executives or with any other key employees, and we do not
maintain key person life insurance for any officers or key employees.

Our success also depends on our ability to attract, integrate, motivate
and retain additional highly skilled technical, sales and marketing and
professional services personnel. Competition for qualified personnel in the
enterprise software industry is intense. To the extent we are unable to attract
and retain a sufficient number of additional skilled personnel our business
will suffer.

Our Aspen platform is a new product and may contain defects or otherwise
perform improperly.

Our Aspen platform was initially released in September 2001, and we
anticipate continuing to add new features, functionality and components.
Complex enterprise software products frequently contain errors or failures,
especially when first introduced or when new versions are released. In the
past, we have discovered errors in our products after their initial release.
Because the Aspen platform products are complex software packages with new
features and functionality being added and new versions being released on a
regular basis, there is a greater likelihood that they may contain such errors.
In addition, since the Aspen platform is targeted at enterprise customers with
large numbers of users, customers and potential customers may have a greater
sensitivity to product defects or

19



---



##### Table of Contents



product integration than the market for software products generally. To
date we have experienced minor errors in the Aspen platform that are typical of
a newly released software product. Although these errors have not had a
material impact on our business, serious product defects could result in loss
of revenue or delay in market acceptance, diversion of development resources,
damage to our reputation, or increased service and warranty costs.

Our debt covenants may significantly restrict our operations.

We are subject to numerous covenants in our agreement with Silicon Valley
Bank that impose financial and operating restrictions on our business. These
restrictions may affect our ability to operate our business, may limit our
ability to take advantage of potential business opportunities as they arise,
and may adversely affect the conduct of our current business. These covenants
place restrictions on our ability to, among other things:



| |  |  | incur more debt;                                                          
| | - |  | --------------------------------------------------------------------------
|
| |  |  | pay dividends, redeem or repurchase our stock or make other distributions;
|
| |  |  | make acquisitions or investments;                                         
|
| |  |  | use assets as security in other transactions;                             
|
| |  |  | enter into transactions with affiliates;                                  
|
| |  |  | merge or consolidate with others;                                         
|
| |  |  | dispose of assets or use asset sale proceeds;                             
|
| |  |  | create liens on our assets; and                                           
|
| |  |  | extend credit.                                                            

In addition, the terms of our indebtedness require that we meet certain
financial ratios and tests. The covenants governing our existing indebtedness
restrict our operations and those of our subsidiaries, and these limitations
could impair our ability to meet such financial ratios and tests. In addition,
our ability to meet these ratios and tests and to comply with other provisions
governing our indebtedness may be affected by changes in economic or business
conditions or other events beyond our control. Moreover, our failure to comply
with our debt-related obligations could result in an event of default that, if
not cured or waived, could result in an acceleration of our
indebtedness. We are currently in violation of certain of these
covenants.

The bank has waived these violations of the covenants without cost
to us, and has indicated that it is willing to amend certain of the covenants so that we are no longer in violation.
However, we cannot assure you that the bank will amend these covenants, that we will not violate these or other covenants in the future or
that the bank will waive any such future violations at no cost to us, or at
all.

If we are unable to build the Click2learn and Aspen brands, we may be unable to
grow our business.

We believe that establishing and maintaining the Click2learn and Aspen
brands will be critical to the success of our enterprise learning strategy and
that the importance of brand recognition will increase due to the growing
number of enterprise learning software products. If our brand building strategy
is unsuccessful, these expenses may never be recovered, and our business could be materially
harmed.

20



---



##### Table of Contents



We may not be able to adapt to rapidly changing technology and evolving
industry standards.

The enterprise learning software market is characterized by rapidly
changing technologies, frequent new product and service introductions, short
development cycles and evolving industry standards. The introduction of new
products and services embodying new technologies and the emergence of new
industry standards may render our products and services obsolete. Our success
depends on our ability to adapt to a rapidly changing landscape and to offer
new products and services to address our customers changing demands. We may
experience difficulties that delay or prevent the successful design,
development, introduction or marketing of our products and services. To the
extent we in fact experience such delays, we may experience difficulty in
attracting new customers and may lose existing ones.

We face the risk of liability for failures to meet unique customer
requirements, and the risk of cost overruns on fixed-price projects.

The failure or inability to meet a customers unique expectations or
requirements in the performance of services could impair our reputation or
result in a claim for damages, regardless of our responsibility for the
failure. Although generally we attempt to limit contractually our liability for
damages arising from product defects and other mistakes in rendering
professional services, these contractual protections are not always obtained
and may not be enforced or otherwise may not protect us from liability. Our
insurance may not be sufficient to cover any of these claims.

In addition, many of our professional services projects are performed on a
fixed-price basis rather than on a time and materials basis. If we do not
accurately predict the costs of these projects, we could incur unexpected
costs. If we do not complete fixed-price engagements within budget, on time and
to clients satisfaction, we bear the risk of cost overruns.

Security and privacy breaches could subject us to litigation and liability.

We host many of our customers enterprise learning software
implementations at our data center and provide access to that software using
the Internet. The Internet is a public network and data is sent over this
network from many sources. Although we take reasonable steps in accordance with
current industry practices to ensure the security of our hosting systems and
customer data, computer viruses could be introduced into our systems or those
of our customers, which could disrupt the operation of our hosting systems or
make them inaccessible to users. In addition, well-publicized Internet security
breaches could deter customers from using the Internet to conduct transactions
that involve the transmission of confidential information. We depend on
Internet service providers and telecommunications companies and the efficient
operation of their computer networks and other computer equipment to enable
customers to access and use hosted software implementations. Each of these has
experienced significant outages in the past and could experience outages,
delays and other difficulties due to system failures unrelated to our systems.

We could become subject to litigation and liability if third parties
penetrate security for our hosting systems or otherwise misappropriate our
users confidential information or if customers are unable to access and use
hosted software implementations. Advances in computer capabilities, new
discoveries in the field of cryptography or other technological events or
developments could result in compromises or breaches of our security systems.
Anyone who circumvents our security measures could misappropriate proprietary
information or cause interruptions in our services or operations. We may be
required to expend significant capital and other resources to protect against
the threat of security breaches or service interruptions or to alleviate
problems caused by breaches or service interruptions.

21



---



##### Table of Contents



International expansion may impose substantial burdens on our resources, divert
managements attention or otherwise harm our business.

Our current plans for expansion into international markets will require
extensive management attention and will require us to rely
extensively on third parties in foreign countries to help conduct our
international operations and conduct sales and marketing efforts. Our success
in international markets consequently will depend to a large degree on the
success of these third parties, over which we have little control. If they are
unwilling or unable to dedicate sufficient resources to our relationships, our
international operations will suffer. Furthermore, our efforts abroad are
subject to a number of additional risks inherent in international operations,
including:



| |  |  | difficulties and costs of staffing and managing foreign offices;
| | - |  | ----------------------------------------------------------------
|
| |  |  | different learning styles and cultures;                         
|
| |  |  | numerous and potentially conflicting regulatory requirements;   
|
| |  |  | export controls, import tariffs and other barriers to trade;    
|
| |  |  | reduced protection of intellectual property rights;             
|
| |  |  | regional political and economic instability; and                
|
| |  |  | fluctuations in currency exchange rates.                        

Our intellectual property may become subject to legal challenges, unauthorized
use or infringement, any of which could diminish the value of our products and
services.

Our success depends in large part on our proprietary technology. We rely
on a combination of copyrights, trademarks, trade secret laws, restrictions on
disclosure and other methods to protect our proprietary technology. While we
have patent applications pending, we do not have issued patents for any of the
technology underlying our Aspen platform. If we fail to successfully enforce
our intellectual property rights, the value of these rights, and consequently
the value of our products and services to our customers, could diminish
substantially. It may be possible for third parties to copy or otherwise obtain
and use our intellectual property or trade secrets without our authorization,
and it may be possible for third parties to independently develop substantially
equivalent intellectual property.

Litigation may be necessary in the future to enforce our intellectual
property rights, to protect trade secrets or to determine the validity and
scope of the proprietary rights of others. From time to time we have received,
and may in the future receive, notice of claims of infringement of other
parties proprietary rights. Such claims could result in costly litigation and
could divert management and technical resources. They could also delay product
shipment or require us to develop non-infringing technology or enter into
royalty or licensing agreements, which agreements may not be available on
reasonable terms, or at all.

Our products include third-party technology, the loss of which could materially
harm our business.

We use some licensed third-party technology components in our products.
Future licenses to this
technology may not be available to us on commercially reasonable terms, or
at all. The loss of or inability to obtain or maintain any of these technology
licenses could result in delays in the introduction of new products or could
force

22



---



##### Table of Contents



us to discontinue offering portions of our enterprise learning solutions
until equivalent technology, if available, is identified, licensed and
integrated. Furthermore, we may become subject to legal claims related to
licensed technology based on product liability, infringement of intellectual
property or other legal theories.

Acquisitions or investments may drain capital and equity resources, divert
managements attention or otherwise harm our business.

In the future we may acquire or make investments in other businesses,
products or technologies. Such acquisitions or investments may require that we
pay significant cash, issue stock or incur substantial debt. In
addition, such
acquisitions or investments may require significant managerial attention, which
may be diverted from our other operations. These capital, equity and managerial
commitments may impair the operation of our business. Furthermore, acquired
businesses may not be effectively integrated, may be unable to maintain key
pre-acquisition business relationships, may contribute to increased fixed costs
and may expose us to unanticipated liabilities.

Our stock price has been and may continue to be volatile.

The trading price of our common stock has been and is likely to continue
to be highly volatile. For example, during the 52-week period ended June 30,
2002, the price of our common stock ranged from $1.50 to $5.05 per share.
Our stock price is subject to continued fluctuations in response to a number of
factors, including:



| |  |  | actual or anticipated variations in quarterly operating results;                                                                  
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | changes in financial estimates or recommendations by securities analysts;                                                         
|
| |  |  | conditions or trends in the e-Learning and enterprise software markets;                                                           
|
| |  |  | announcements by us or our competitors of technological
innovations, new products or services;                                    
|
| |  |  | announcements by us or our competitors of significant
acquisitions, strategic partnerships, joint ventures or
capital commitments;
|
| |  |  | additions or departures of key personnel;                                                                                         
|
| |  |  | sales of our common stock; and                                                                                                    
|
| |  |  | general market conditions.                                                                                                        

The stock market in general, and the market for enterprise software and
technology companies in particular, recently has experienced extreme price and
volume fluctuations that have been unrelated or disproportionate to the
operating performance of many of the affected companies. These broad market
and industry factors may depress our stock price, regardless of our operating
performance.

In the past, companies that have experienced volatility in the market
price of their stock have been subject to securities class action litigation.
We may be the target of this type of litigation in the future. Securities
litigation against us could result in substantial costs and divert our
managements attention, which could seriously harm our business.

Our stock may be delisted from the Nasdaq
National Market, which could further decrease our stock price and
make it difficult to raise capital.

Our common stock is
currently listed on the Nasdaq National Market. To maintain such
listing, we must continue to satisfy ongoing listing requirements,
including consistently maintaining a minimum bid price for the common
stock of $1.00 per share or more. Our common stock has traded below
the $1.00 minimum bid requirement since July 22, 2002. If our
common stock were to trade below the $1.00 minimum bid requirement
for a period of 30 consecutive business days or more, Nasdaq could
initiate delisting procedures and we could spend material financial
and managerial resources in our efforts to avoid delisting over the
next 90 business days. If we were to be delisted, we would likely
seek listing of our common stock in the over-the-counter market,
which is viewed by many investors as a less liquid marketplace. Among
other things, our common stock may then constitute penny
stock, which would place increased regulatory burden upon
brokers, making them less likely to make a market in our stock. Loss
of our Nasdaq National Market status could also make it more
difficult for us to raise capital or complete acquisitions.




Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market Rate Risk.We are exposed to market risk related to changes in
interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.

Interest Rate Risk.We hold our assets primarily in cash and cash
equivalents, such as short-term marketable debt securities, money market funds
and other cash equivalents. We minimize risk by investing in financial
instruments with maturity of three months or less. As a result, if market
interest rates were to increase immediately and uniformly by 10% from levels at
December 31, 2001, the fair value of cash and cash equivalents would not change
by a material amount.

Foreign Currency Exchange Risk.We have foreign currency risk as a result
of foreign subsidiary activities. For the three and six months ended June 30,
2002, international revenues from foreign subsidiaries accounted for
approximately 4% of total revenues. All foreign subsidiaries use the local
currency as their functional currency.

Our exposure to foreign exchange rate fluctuations arises in part from
intercompany accounts in which costs

23



---



##### Table of Contents



incurred in the United States are charged
to the foreign subsidiaries. These intercompany accounts are typically
denominated in the functional currency of the foreign subsidiary in order to
centralize foreign exchange risk with the parent company in the United States.
We are also exposed to foreign exchange rate fluctuations as the financial
results of foreign subsidiaries are translated in U.S. dollars in
consolidation. As exchanges rates vary, these results, when translated, may
vary from expectations and adversely impact overall expected profitability. The
effect of foreign exchange rate fluctuations for the three and six months ended
June 30, 2002 was not material. Due to the substantial volatility of currency
exchange rates, among other factors, we cannot predict the effect of exchange
rate fluctuations on our future operating results.




PART IIOTHER INFORMATION




Item 1. Legal Proceedings

Not applicable.




Item 2. Changes In Securities and Use of Proceeds

At the 2002 Annual
Meeting of Stockholders, our stockholders approved an amendment to
our Certificate of Incorporation to increase the number of shares of
authorized common stock from 40,000,000 shares to 100,000,000 shares
and to increase the number of shares of authorized preferred stock
from 2,000,000 shares to 5,000,000 shares.




Item 3. Defaults Upon Senior Securities

Not applicable.




Item 4. Submission of Matters to a Vote of Securities Holders

The 2002 Annual Meeting of the Stockholders of Click2learn was held on May
29, 2002 at 110  110th Avenue NE, Bellevue, Washington. The meeting was held
pursuant to a Notice of Annual Meeting of Stockholders mailed to the
stockholders on or about April 25, 2002. Three proposals were submitted to the
stockholders and approved at the annual meeting, as follows:

Proposal 1:Election of Sally Narodick, Jonathan Klein and John W. Coné as
Class I directors to serve until the annual meeting of the stockholders to be
held in 2005 and election of Vijay Vashee as Class III director to serve until
the annual meeting of the stockholders to be held in 2004. The number of votes
cast for or withheld from each nominee, both in person and by proxy, was as
follows:

|               |  |                |            |                |  |           |            |              |  |  |            |  |  |  |            | 
|-------------- |  | -------------- | ---------- | -------------- |  | --------- | ---------- | ------------ |  |  | ---------- |  |  |  | ---------- | 
|               |  | Sally Narodick |            | Jonathan Klein |  | John Coné |            | Vijay Vashee
|               |  |                |            |                |  |           |            |             
|Votes For      |  |                | 20,112,253 |                |  |           | 16,601,905 |              |  |  | 20,175,490 |  |  |  | 20,165,163 | 
|Votes Withheld |  |                | 667,538    |                |  |           | 4,177,886  |              |  |  | 604,301    |  |  |  | 614,628    | 

Proposal 2:An amendment to the first paragraph of Article IV of our
Restated Certificate of Incorporation to increase the number of authorized
shares of Common Stock to 100,000,000 shares from 40,000,000 shares and to
increase the number of authorized shares of Preferred Stock to 5,000,000 shares
from 2,000,000 shares. The number of votes cast for, cast against or
abstaining from Proposal 2, both in person and by proxy,  broker
non-votes, and other non-votes was as follows:

|                 |  |  |            | 
|---------------- |  |  | ---------- | 
|Votes For        |  |  | 14,118,544 | 
|Votes Against    |  |  | 1,158,385  | 
|Abstaining       |  |  | 8,552      | 
|Broker Non-votes |  |  | 5,494,310  | 
|Other Non-votes  |  |  | 3,480,155  | 

Proposal 3:Ratification of the appointment of KPMG LLP as our
independent accountants to perform the

24



---



##### Table of Contents



audit of our financial statements for
2002. The number of votes cast for, cast against or abstaining from Proposal 3,
both in person and by proxy, was as follows:

|              |  |  |            | 
|------------- |  |  | ---------- | 
|Votes For     |  |  | 20,734,354 | 
|Votes Against |  |  | 13,625     | 
|Abstaining    |  |  | 31,812     | 




Item 5. Other Information.

On July 12, 2002, Dr. Shelley Harrison resigned as a member of the Board of
Directors and the Audit Committee. Dr. Harrison resigned because his current
schedule did not permit him to devote the time he felt was appropriate to
Click2learn. There has been no disagreement between Click2learn and Dr.
Harrison on any matter relating to Click2learns operations, policies or
practices. Vijay Vashee has been appointed to fill the vacancy on the Audit
Committee resulting from Dr. Harrisons resignation. The Board does not yet
have a nominee to fill the vacancy on the Board resulting from Dr. Harrisons
resignation.




Item 6. Exhibits and Reports on Form 8-K



| | (a)   |  | Exhibits.                                                                                                                                       
| | ----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|
| | 3.01  |  | Amendments to
Amended and Restated Certificate of Incorporation(1)                                                                              
|
| | 10.01 |  | Click2learn Change of Control Severance Plan                                                                                                    
|
| | 99.01 |  | Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbane-Oxley Act of
2002
|
| | 99.02 |  | Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbane-Oxley Act of
2002
|
| | (b)   |  | Reports on Form 8-K                                                                                                                             

A report on
Form 8-K dated April 4, 2001 was filed announcing
Click2learns preliminary results for fiscal first quarter 2002 and
the departure of Dennis Worsley as Executive Vice President,
Worldwide Sales and Marketing. No financial statements were filed with
such report.

_______________
(1) Incorporated herein by reference to Click2learns
Description of Capital Stock on Amendment No. 1 to Form 8-A
filed on August 8, 2002.

25



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

|                |  |                                                                                                                                              
|--------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|                |  | CLICK2LEARN, INC                                                                                                                             
|               
|               
|August 14, 2002 |  | /s/John D. Atherly                                                                                                                           
|                |  |                                                                                                                                              
|Date            |  | John D. Atherly
Vice President, Finance and Administration
and Chief Financial Officer
(Duly Authorized Officer and Chief Accounting Officer)

26



---



##### Table of Contents






EXHIBIT LIST

|      |  |                                                                                                                                                 
|----- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|3.01  |  | Amendment to Amended and Restated Certificate of
Incorporation(1)                                                                               
|10.01 |  | Click2learn Change of Control Severance Plan                                                                                                    
|99.01 |  | Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbane-Oxley Act of 2002
|99.02 |  | Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbane-Oxley Act of 2002

_______________
(1) Incorporated herein by reference to Click2learns
Description of Capital Stock on Amendment No. 1 to Form 8-A
filed on August 8, 2002.